Sunday, November 25, 2012

Banking must not be left in the shadows, by Gary Gorton, Commentary, Financial
Times: ... Addressing the details of the recent financial crisis leaves open
the larger question of how it could have happened in the first place. ... One of
the findings of the Financial Stability Board report is that the global shadow
banking system grew to $62tn in 2007, just before the crisis. Yet we are only
now measuring the shadow banking system. ...

Measurement is the root of science. Our measurement systems, national income
accounting, regulatory filings and accounting systems are useful but limited.
... Now we need to build a national risk accounting system. The financial crisis
occurred because the financial system has changed in very significant ways. The
measurement system needs to change in equally significant ways. The efforts made
to date focus mostly on “better data collection” or “better use of existing
data” – phrases that, at best, suggest feeble efforts. A new measurement system
is potentially forward-looking in detecting possible risks.

Another problem is conceptual. Why weren’t we looking for the possibility of
bank runs before the crisis? The answer is that we did not believe a bank run
could happen in a developed economy. ... Why did we think that? For no good
reason. But, when an economic phenomenon occurs over and over again, it suggests
something fundamental... Another law, we now know, is that privately created
bank money is subject to runs in the absence of government regulation.

I'll just add the periodic reminder that we do not yet have the regulation in place that is needed to address the problem of bank runs of "privately created
bank money." Gary Gorton is skeptical that we can ever solve this problem, that's one of the pointsof th ecolumn, but if that's the case then we should be doing all we can to ensure that the consequences of a shadow bank run are minimized, and there is much more we can do along these lines.

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Banking Must not be Left in the Shadows

I agree with Gary Gorton:

Banking must not be left in the shadows, by Gary Gorton, Commentary, Financial
Times: ... Addressing the details of the recent financial crisis leaves open
the larger question of how it could have happened in the first place. ... One of
the findings of the Financial Stability Board report is that the global shadow
banking system grew to $62tn in 2007, just before the crisis. Yet we are only
now measuring the shadow banking system. ...

Measurement is the root of science. Our measurement systems, national income
accounting, regulatory filings and accounting systems are useful but limited.
... Now we need to build a national risk accounting system. The financial crisis
occurred because the financial system has changed in very significant ways. The
measurement system needs to change in equally significant ways. The efforts made
to date focus mostly on “better data collection” or “better use of existing
data” – phrases that, at best, suggest feeble efforts. A new measurement system
is potentially forward-looking in detecting possible risks.

Another problem is conceptual. Why weren’t we looking for the possibility of
bank runs before the crisis? The answer is that we did not believe a bank run
could happen in a developed economy. ... Why did we think that? For no good
reason. But, when an economic phenomenon occurs over and over again, it suggests
something fundamental... Another law, we now know, is that privately created
bank money is subject to runs in the absence of government regulation.

I'll just add the periodic reminder that we do not yet have the regulation in place that is needed to address the problem of bank runs of "privately created
bank money." Gary Gorton is skeptical that we can ever solve this problem, that's one of the pointsof th ecolumn, but if that's the case then we should be doing all we can to ensure that the consequences of a shadow bank run are minimized, and there is much more we can do along these lines.